Key takeaways

• An Health Savings Account (HSA) is a tax-advantaged savings account used for medical expenses
• It is triple tax free and can be invested to pay for medical expenses later
• Be diligent about keeping your medical receipts & supporting documentation
• If you have a lot of current annual medical expenses you may want to consider another type of health insurance plan

What is an HSA

A Health Savings Account (HSA) is a special tax-advantaged savings account used for medical expenses. A HSA is paired with a high deductible health plan or other eligible health insurance plan.

Why HSA

• There’s no income limitation for wealthy people. As you climb up on the wealth ladder there are fewer tax advantaged accounts, you’re eligible for. There is no income restriction for an HSA
• it does not affect contribution limits of other accounts like IRA’s, 401k’s, 403b’s
• NEVER pay tax on the money, that’s right never! The money put into an HSA is on a pre-tax basis and as long as the money is used for qualified medical expenses the money can grow and be taken out tax free. If you don’t use up all the money for medical expenses you can take the money out after age 65 but will pay taxes on it similar to an IRA account and will be considered ordinary income to you. If you take the money out before age 65 and don’t use it for qualified medical expenses, there is a hefty penalty of 20% plus the taxes you have to pay on the money taken out.

Eligible health expenses

Different lists on the internet may have different interpretations of the IRS I.R.C. § 213(d) so you will want to do your diligence before blindly assuming something is covered if it falls in a grey zone. Here is a list of what is covered.

What Medical Expenses Are Included

What Expenses Aren’t Includible

HSA’s have only been around since 2003 and what is considered a medical expense has changed and I expect it to continue. The great news is the trend seems to be more expansive than restrictive an example is feminine hygiene which used to not be covered now is. Besides yourself you can also use your HSA to pay qualified medical expenses for the following people per IRS Publication 969.

• You and your spouse.
• All dependents you claim on your tax return.
• Any person you could have claimed as a dependent on your return, but couldn’t because:
  • The person filed a joint return
  • The person had gross income of $4,200 or more; or
  • You or your spouse if filing jointly, could be claimed as a dependent on someone else’s 2019 return.

HSA is not a FSA

Some individuals when they hear the word HSA they say they already have used a FSA. While a Health Savings Account (HSA) and Flexible Spending Account (FSA) are similar they are not the same thing. The HSA if available reigns superior. A FSA has lower annual contribution limits compared to a HSA. The money in an FSA also has a rule of using the money or losing it if unused by the end of the year. There is no ability to save year after year in an FSA investing the balance growing the account like you can in an HSA making it a retirement swiss army knife.

Who is eligible

To be eligible you must have a High Deductible Health Plan (HDHP), you can keep the contributions made to your HSA in the years you had a high deductible health plan (HDHP) you just can’t make additional contributions if you switch to another type of medical plan. What qualifies as a High-Deductible Health Plan (HDHP) is established by the IRS annually and for 2020 is as follows.

The out-of-pocket maximum varies by plan and includes deductibles, co-payment, and co-insurance. The out-of-pocket maximum does not include your health insurance premiums.

If you have a HSA plan only part of the year then the max amount you are able to contribute to the account for the year is prorated for the months you were enrolled in the plan. The amount you can contribute to a HSA annually is as follows.

Contribute through your work to avoid FICA

You can have as many HSA’s as you want but the total annual contribution limit between the accounts will still be the same. Even if you don’t keep your HSA at your work You should always initially contribute to your HSA through work because this makes the contribution also FICA exempt. If you transfer the HSA from your workplace to an outside HSA provider, it will remain FICA exempt but if you made the contribution outside of work initially you won’t get this extra tax benefit. This benefits both lower and higher income earners because while a high income earner may already max out Social Security tax this still saves them on Medicare tax.

The best overall Health Savings Account (HSA) provider

It’s often times workplaces don’t have very good HSA providers; either they have lots of hidden administrative expenses or they have limited to no investment options. However, do not fret that’s no big deal since you can open an HSA account with any provider outside of work long as you have a HSA eligible health plan. The HSA provider landscape is continuously changing at a rapid pace, but the current best HSA provider is Lively. There are other great HSA providers, but they are my preferred choice. They have a pretty simple user interface and for individuals there is no fee for having an account with them. They also allow individuals to open a brokerage account with TD Ameritrade at no additional cost. This allows the HSA to be invested in virtually anything rather than being limited to a short investment fund list like many providers. Different HSA providers have different levels of convenience for withdrawing money out of the account via debit cards or other methods. The power in having an HSA though is not in using it like another debit card like you would with a FSA.

Investing your HSA

The real power of an HSA is combining the tax-free nature of the account with investing. A huge portion of existing money in HSA’s sits in cash collecting close to nothing in interest. Investing the money and growing it tax free allows the account to be a quasi-retirement account. Unlike other retirement accounts HSA’s unfortunately are limited to medical expenses but medical expenses tend to be the largest expense people have in retirement so I wouldn’t be too concerned with having too much money in an HSA.

Reimburse yourself later, letting your money grow tax free longer

There is also one other secret and very important caveat to HSA’s that is you can pay for the expenses now, save the receipts, then later at a future date take the money out tax free. That means the money you take out of your HSA in retirement doesn’t have to be from medical expenses then and could have been from previous years. This strategy allows you to rack up more receipts to let you keep your money invested longer. For an expense to be eligible for this strategy the expense must have been paid after the HSA account was already open. When you take a distribution out of your HSA you will file Form 8889. The IRS doesn’t require you to submit receipts with the tax return, but you will want to keep very organized receipts and supporting documentation in case of an IRS Audit.

Who is this strategy not for

The HSA is one of the most tax advantaged accounts out there, but the strategy isn’t for everyone. Firstly, if you have a lot of current medical expenses it may not make sense to have a high deductible health plan. High-Deductible Health Plans have next to nothing for insurance assistance until you hit your deductible. You will need to compare your annual expected healthcare costs and compare the tradeoff between going with another health insurance plan that isn’t HSA eligible. Another thing to consider is when investing the account is health care costs tend to be unexpected and this can make it tricky to define your time horizon for the money and you need to strategize accordingly ahead of time.

Conclusion

HSA’s have some caveats to using them and they present some unique planning challenges. However, properly used they are an extremely powerful account, and their usage will likely continue to grow in size as a supplementary retirement account for many people. As HSA’s become more widely used and medical expenses continue to climb in America there remains uncertainty on how they will continue to evolve in the future but it looks, they are here to stay for quite some time.